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Elementary Research on Equity Incentive


Along with the growing competitive pressures, more and more enterprises realize the importance of core competitiveness as well as talent management. Thus, they use equity incentive plans to retain the core staff and improve the initiative and enthusiasm of the employees. Article 2 of the Measures for the Administration of the Equity Incentives of Listed Companies provides that "Equity incentive in this Measures refers to a long-term stimulation in listed companies through granting equity shares to directors, senior management personnel and other employees." Although the definition implies that the applicable subject is limited to listed companies, it can be of significant reference to the understanding of equity incentive. The author thinks that equity incentive plan is a tool of long-term stimulation in a broad sense. Where the company and its shareholders satisfy certain conditions, the company will grant the company's stocks and their associated rights as well as the profits right derived from their derivative values to a specific group of employees.

I.Origins and Development of Equity Incentive


During the reign of Emperor Daoguang of the Qing dynasty, the workers (i.e., the employees) received salaries (i.e. Xin Jin) as well as dividends from the Shanxi Bill Bank. The operator (i.e., senior executive) owned the "individual stock" which is also known as "labor stock" or "manual labor stock". Instead of paying money, the stocks were issued by the employer according to the employee's seniority, position, contribution and etc. As usual, when employees have worked for a certain number of years, they can be entitled to the individual stocks and the shares in the profits of the bank. Throughout the history of the bank operation, incidents such as absconding, corruption or fraud never happened inside the bank, although the exchange undertaken by the bank reached more than one billion silvers. The miracle attributed to the strict internal management and the effectiveness of the incentive mechanism.


According to incomplete statistics, in the period from 2005 to 15 September 2011  there were 290 listed companies adopting equity incentive plans, accounting for 12.83% of the total number of listed companies with class A shares. Based on the market distribution of the 290 listed companies, the proportion of small and medium enterprise board is the highest, with the number of 116, while there are 44 GEMs  accounting for 16.67% of the total number of GEMs. It can be seen that small and medium-sized enterprises and private enterprises are more actively using incentives to retain talents with more flexibility.

II.Commercial value and legal value of equity incentive

a.Commercial Value

1)Reconciliation of conflicts arising from profit distribution

The contribution of employees, especially senior executives, is often difficult to be fully reflected in the original enterprise profit distribution system. As usual, employees can only obtain salaries and bonuses, but their technical or managerial competencies are not reflected in the remuneration, thus results in the employee's disengagement at work and the lack of vitality in the enterprise. However, the equity incentive plan can reflect the value factors such as managerial and technical competencies by sharing the profits. On the one hand, it is advantageous to the enterprise to retain key talents, on the other hand, it improves employees' self-consciousness and enthusiasm to work in pursuit of profit maximization based on the shareholder perspective.

2)A win-win for both enterprises and employees

After the enterprise implements the equity incentive plan, the employees often play the dual roles of the laborers and the enterprise owners, which successfully ties the personal interests with the overall benefits and long-term development of the enterprises. On the one hand, the development status of enterprises and the overall economic benefits are directly related to the expected return for all employees and thus stimulating the creativity of employees. Employees, on the other hand, make contributions to the enterprise while striving to maximize personal interests. It solves the conflicts between individual interests and the company's interests, creates more values in the benefit sharing, and promotes the long-term development of the enterprise.

b.Legal value

1)Conducive to the optimization of corporate governance structure

In order to achieve long-term and stable development, enterprises must attach importance to the establishment of corporate governance structure. In corporate governance, the most important thing is to establish an effective restraint mechanism. The occurrence of low operating efficiency, substantial loss of assets and monopoly of decision-making is partly due to the lack of a sense of ownership. Through the equity incentive plan, employees are given the identity as a shareholder, as well as owner and operator of the enterprise. It helps realize profits maximization and effectively solves the problem of the mutual supervision between owners and operators.

2)Conducive to the construction of a new type of labor relation

According to the Marxism views, capital and labor force are always against each other, which is the relationship between exploiter and exploitee. Based on the current practice in the Western countries and our country, the above contradiction can be alleviated to a certain extent by constructing a feasible equity incentive system within the legal framework. By granting employees equity or the related rights and interests, employees and enterprises can form a community of interests thus constructing a new type of labor relation.

III.Key points and difficulties of designing an equity incentive scheme

a.Specify the objectives of equity incentives

When an enterprise and its shareholders are ready to implement equity incentive plan, the goals of equity incentive should be clearly defined. Without goals, equity incentive will lose its meaning.

Generally speaking, the targets of equity incentive are the followings: talent attraction (by giving equity incentive while employing key technicians or management personnel), employee motivation (by granting key technicians or managers certain types of motivation to promote the company's development), employee stock ownership (to stabilize the workforce and share the earnings growth with the founding shareholders), resources integration (to stabilize external resources with important value or influence for enterprises, such as commercial banks, upstream and downstream customers, etc.). For non-listed companies, equity incentives can also help ease the pressure from remuneration on companies. By means of equity incentive, companies can reduce operating costs cash outflow properly. For the original shareholders, implementing the equity incentive plan is beneficial in reducing the moral hazard of the professional managers, thus realizing the separation of ownership and management.

Thus, equity incentives focus on encouragement. Motivation is not equal to reward. If equity incentive plans were implemented without full consideration and the enterprise's shares were given out easily, it would be a total loss for the company when the distribution is unequal or the effect is adverse. Therefore, it is extremely wrong to carry out the equity incentive plan blindly, so choosing a proper motivation path in accordance with its objectives is key to equity incentives.

b.Choose an appropriate incentive model for a particular enterprise

At present, in addition to regular models based upon the specified rules for equity incentives of listed company at the legislative and policy levels (such as secondary restricted stock), the most common types of equity incentive models include: equity rights or stock options, equity (options) or the corresponding share dividends (dividends, equity appreciation, etc.), employee's actual holding or virtual holding of equity, etc. In the concrete implementation of equity incentive plan, enterprises need to find the best fit based upon the needs of the enterprise and the actual situation through different ways, so as to achieve the desired effect. In practice, many companies will choose to adopt a single method or several types of equity incentive simultaneously, while some of them will set up a specified plan of equity incentive in accordance with their own needs and the actual situation.

As the author thinks, for listed companies there are many relatively comprehensive requirements on equity incentives at the legislative and policy levels. The specific implementation of the incentive plans needs to dock with the brokerage, exchange, bank, etc., in which the flexibility is lower. For non-listed enterprises, the implementation can make reference to the law and the relevant system. However, there is certain flexibility and autonomy in practice. As long as it is not in violation of the prohibitive provisions of laws and policies and is able to perform risk prevention strategy effectively, it is entirely possible to formulate an equity incentive plan in accordance with the enterprise's outstanding characteristics and its special needs.

c.Owners' determination and preliminary preparation for implementing equity incentives

Frankly speaking , apart from virtual shares and the rights to dividends, the so-called equity incentive in non-listed enterprises that is provided to the eligible person when certain conditions are satisfied, is usually derived from selling existing equity shares or increasing share capital. While in listed enterprises, they use private placement and grant the additional stocks to the eligible person upon meeting certain conditions. Previous business owners are not usually the only subject. The owner should be determined and confidence when ascertaining the amount of incentive equities and precipitation share from his own shareholding, otherwise the equity incentive plan is just an empty talk. During the implementation of equity incentive plans, if the employees need to fund the capitals in accordance with the share price, many of them will reject or cease to participate in the plan because of uncertainty of its outcome and insufficient financial resources. At that time, the business's owners should adopt other methods such as donation, sale for a lower price or personal loans, so as to promote the implementation of the equity incentive plan. Also, it is necessary to deal with the problems arising from tax and etc. Therefore, prior to the implementation of the equity incentive plan, the enterprise's owners must be fully prepared for the funds and efforts that may be required during the implementation process.

d.Formulate a feasible implementation plan according to the existing incentive model

Upon the aforementioned research and full preparation, a feasible implementation plan should be formulated and fixed in written form. Apart from the aim of solidifying the equity incentive measures, another objective of formulating a specific implementation plan is to prevent potential risks during the implementation and violation of the national laws and regulations, etc. Therefore, many enterprises' equity incentive schemes are drafted by professional lawyers and being finalized through constant communication during the drafting process.

Based on the experience of River Delta Law Firm in designing equity incentive plans , the process of drafting the plan should include: understanding, mastering and refinement of the objective of equity incentive, the collection of relevant information (including but not limited to equity distribution, employees' positions and salaries, business operations and net assets, any plans to be listed in the short term, local policies, etc.), the formulation of plan and legal opinions based on the information analysis and communication with employees and other personnel, etc. If needed, the scope of work of the lawyer will also expand to include modification of articles of association, draft of the resolution of shareholders' meetings or meetings of the board of directors, assistance in setting up relevant enterprises, communication with particular staff, prevention and representation of litigations, etc.

e.HR's role in designing equity incentive plan

In addition to the participation of lawyers, securities firms and banks, the HR department of the company plays an important role in the stage of designing equity incentive plan. Under equity incentive scheme, the employee is required to meet certain conditions before enjoying the real benefits, for example, a time limitation from the date of signing the grant agreement, additional conditions that the operation of business shall reach to a specified summit, etc. For employees who participate in the equity incentive plan, they are requested to meet certain personal performance indicators. The individual performance index settings shall be legal, feasible, implementable and fair in order to avoid any controversy on whether the performance indicators are completed. Since each enterprise has different positions or employees, it is highly recommended to involve HRs in designing personal performance indicators, so that they may design specific performance indicators according to specific situations.

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